10/01/2002 @ 11:33AM

Kick Music Execs While They're Down

Theoretically, a price-fixing scheme is a surefire way to maintain revenue–even if it is an efficient way to land in jail. But for such a blazingly simple plan, those clever music executives proved that if anyone can screw it up, they can.

After a two-year battle waged against the major record companies and music retailers–Bertelsmann,
EMI
,
AOL Time Warner
‘s
Warner-Elektra-Atlantic,
Sony Music Entertainment
,
Vivendi Universal
‘s
Universal Music,
Trans World Entertainment
, Tower Records and Musicland Stores–New York state and Florida attorneys general announced a $143.1 million settlement.

The companies did not admit guilt in the alleged price-fixing scheme, but they will pay $67.4 million in cash to consumers who got ripped off buying overpriced CDs between 1995 and 2000. They will also distribute $75.5 million worth of CDs to nonprofit organizations and schools. (The teachers undoubtedly will be grateful for free copies of Eminem’s latest album.)

The settlement gives the distinct impression that the record companies’ priority was to make the case go away quietly. Although music executives said the legal costs of the case didn’t make it worth fighting for, it’s a conspicuous cop-out considering that legal fees never stopped them from going to absurd lengths to win their battles against Napster or MP3.com.

While illegal, the benefits of price-fixing are seemingly obvious. If a few leading companies agree to set prices at a certain range, nobody loses in the event of a price war–well, besides the customers, and they don’t really count. But if the big five were in cahoots on a price-fixing scheme, how did they manage to lose money on it?

It’s been a rough few years in the music industry. CD shipments dropped 7% in the first six months of 2002, and seizures of counterfeit CDs were up by 69.9%. That follows a 5.3% decline in CD shipments in 2001, according to PricewaterhouseCoopers. Those declines are showing on the labels’ bottom lines. In March, EMI said it would cut 20% of its employees and eliminated 400 acts from its roster. In August, Universal Music Group said its operating income in the first six months of the year had dropped 28% compared with the same period last year.

Music executives have done nothing but bellyache about sagging sales and profits, and they have blamed everyone but themselves for it. At first they blamed the file-swapping services for cannibalizing sales, then they blamed the artists for not producing enough hits. In truth, it could have been the industry’s alleged price-fixing arrangement that crippled music sales.

Price-fixing is only beneficial at a range where it can support sales. It would make no sense, for example, for McDonald’s (nyse: MCD) and Burger King to agree to set the price of a hamburger at $1,000. It would be even more ridiculous for McDonald’s and Burger King to try to sell $1,000 hamburgers at the same time that some kid is hanging outside the chains giving hamburgers away for free. Even if the chains could theoretically make $999 on each sale, the chances of a sale would be astronomical.

This is essentially what happened in the music business. CD prices may have been set too high, but they were also set too high at a time when record companies were getting eaten alive by the Napsters of the world. It could be argued that if CD prices were cut in half, consumers might be willing to buy more albums by unknown artists, since the purchase wouldn’t be such a large investment. And the more unknown artists sell records, the less dependent labels would be on hits from pop idols such as Britney Spears.

But more important, would Napster even have existed if there hadn’t been a demand for it? The record industry essentially stoked the fires of the pirate music market by setting prices prohibitively high. Necessity is, after all, the mother of invention.